Jun 28, 2008

Oil Slick

T N Ninan / New Delhi June 28, 2008, 0:34 IST
There is much criticism of the government and the Reserve Bank for their handling of the macro-economic problems caused by the spurt in international oil prices. Setting aside the question of who deserves how much criticism and for what, take a short history lesson on what oil prices have done to India, starting with the first oil shock, which was when Opec moved in response to the Yom Kippur war of October 1973 and took oil prices up sharply to the equivalent, in today's context, of $110/barrel.

All those who have been arguing that the Manmohan Singh government should have passed on the full impact of the present oil price increase (and that includes this newspaper), should give Indira Gandhi credit for taking the bit between her teeth and jacking up oil product prices overnight. The price index for the fuel sub-set went up by 80 per cent in barely a year, as a result. General inflation in 1973-74 rose to 20 per cent, and 25 per cent the following year. The fall-out wasn't long in coming. Student mess bills went up in Gujarat, sparking off an agitation that became a movement for unseating the state government. George Fernandes launched a railway strike, and another fire was lit in Bihar against corruption. Before you knew it, Jayaprakash Narayan had started an all-India agitation against the government. In the summer of 1974, Mrs Gandhi finally moved against inflation, imposing a dearness allowance freeze, restricting dividend payouts by companies, and cracking down on money supply. The stock market tanked overnight and the economy stalled, but in three months the inflation curve began dropping, and the JP movement soon began losing steam. It was in fact petering out when the unrelated Allahabad High Court judgment created a fresh crisis that led to the Emergency. Though no one can argue that it was the only cause, Mrs Gandhi's long slide down began with her decision to raise petrol and diesel prices, and the runaway inflation that resulted.
The second oil shock came in 1979-80, when prices touched the current equivalent of about $90 per barrel. The government raised fuel prices, inflation soared from nothing in one year to 17 per cent in the next, GDP actually shrank 5 per cent in the wake of a bad harvest, and there was widespread resentment against what was seen as an incompetent government, which got a drubbing in the election that followed. The foreign exchange situation stabilised only after the new government under Indira Gandhi negotiated what was then the largest ever loan taken from the International Monetary Fund, of $5 billion.
Cut to January 1986. Rajiv Gandhi had just enjoyed a year-long honeymoon with the country through his long first year as Prime Minister. Then he raised oil product prices. There was an almighty uproar, and the government had to roll back the price increase in a matter of weeks, but by then Rajiv's honeymoon was well and truly over and he never recovered. Five years later, in 1990, the first Gulf crisis sparked off a sharp spurt in oil prices, the government kept postponing key decisions and before you knew it the country had run out of foreign exchange. This time, though, there was a happy ending as the economic reforms got launched.
In other words, high oil prices light a fire, every time. In today's context, if the government tries to cushion the impact of oil prices, the fiscal deficit (correctly measured) goes sky-high. If oil prices are raised even slightly, inflation marches into double-digits. The RBI then feels obliged to jack up interest rates, pushing the economy into a slowdown, if not a recession, and what was in the world of reasonable oil prices a sunny economy slips into gloom and doom.

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